Key Idea: Topic 2.7 covers three tools governments use to intervene in markets: price controls (ceilings and floors), indirect taxes, and subsidies. Each creates winners, losers, and a deadweight loss.
✅ Core definitions
- Price ceiling
- Legal maximum price set below equilibrium → shortage, black markets (e.g. rent controls).
- Price floor
- Legal minimum price set above equilibrium → surplus (e.g. minimum wage, agricultural prices).
- Indirect tax
- Tax on goods/services — specific (fixed per unit) or ad valorem (percentage of price) → S shifts left.
- Subsidy
- Payment to producers → S shifts right → lower price, higher quantity.
Price ceilings go BELOW equilibrium. Price floors go ABOVE. If set the wrong way, they have no effect.
📊 Tax incidence and elasticity
- The more inelastic side bears more of the tax burden
- Inelastic demand (cigarettes) → consumers pay most of the tax
- Inelastic supply → producers absorb most of the tax
- Same logic for subsidies — the more inelastic side gets more benefit
⚖️ Evaluation — all three tools
- All three create deadweight loss (welfare loss vs free market)
- Price controls → shortages/surpluses, black markets, reduced quality
- Taxes → higher consumer price, lost CS and PS, but government gains revenue
- Subsidies → lower consumer price, but opportunity cost and possible overproduction
In diagram questions: always shade the deadweight loss triangle, label government revenue (taxes) or government expenditure (subsidies), and show the incidence split.